Subscribe
Share
Share
Embed
Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome ot the Confluence Investment Management Bi-Weekly Geopolitical Report for April 22, 2024. I'm Phil Adler. The changing face of war makes it difficult for investors to identify exactly when war begins, when it ends, and when is the right time to implement a wartime investment strategy. Confluence associate market strategist Daniel Ortworth joins us today to offer some guidance. Daniel, I guess I've always thought loss of life is an essential characteristic of war as enemies attempt to force their will on each other. In your report though you suggest loss of life may no longer be such a useful guidepost. How has technology changed the landscape?
Daniel Ortwerth:You know Phil, I think it is more a case of an increasing number of guideposts. Loss of life will always be guidepost number 1. Other traditional guideposts, such as destruction of military forces, tanks, planes, etcetera, and the bombing of factories and railroads also still hold true. However, as a result of 21st century advances in technology, the spectrum of war has become wider, encompassing more guideposts. If, as you say, war is a struggle between 2 nations for relative power so that they can force their wills upon each other, and one nation can undermine the foundational economic vitality of its adversary by means of an electronic attack, then loss of economic production at home through enemy has become another guide post of war.
Phil Adler:So it might be useful for investors to view technology as a violent means to achieve an end even when there is no loss of life?
Daniel Ortwerth:Yes, Phil. I think that's right. Let me illustrate with a quick example.
Daniel Ortwerth:Say that one country is trying to prevent its enemy from getting reinforcements to the front, and it uses its air force to bomb a key railroad that the enemy uses to move its troops and equipment from the home front to the battlefront. If the bombing raid is successful and the railroad is destroyed, then that country has succeeded through an obvious act of violence, which we define as the use of force to injure or damage or destroy in starving its enemies' frontline forces of critical reinforcements. Now say that one country is trying to prevent another country's economy from functioning correctly, and it uses an Internet virus to infiltrate a key petroleum pipeline, for example, that supplies essential fuel to an entire region's factories and gas stations. If the virus is successful and destroys the control system for the pipeline, then that country has succeeded through a not so obvious act of violence, but violence nonetheless in starving a portion of its enemy's home front of critical fuel.
Phil Adler:Well, the face of war has continually changed through history as weaponry became more advanced. However, what's happening now seems to be uniquely radical. Do you agree?
Daniel Ortwerth:Yes, Phil. I think you're right again in more than one way. First of all, these new high technology attacks really stretch our understanding of violence. We normally think of violence as an overtly physical attack, something that we can see or feel like a bullet shot at a soldier or a bomb dropped on a building.
Daniel Ortwerth:Can we really think of electrons going through the Internet as an instrument of violence? Indeed, we can, and in fact, we must. Secondly, the source and destination of the attack could be literally anywhere in the world and, for that matter, worlds apart. The pipeline example I just mentioned draws upon the real world case of an attack on the East Coast colonial pipeline 3 years ago, as many of our listeners might remember.
Daniel Ortwerth:Now a crime organization perpetrated that attack for simple financial gain, so that was not an act of war. However, it illustrates the point while the pipeline that got disabled was in the Eastern United States, the perpetrators of that attack were in Eastern Europe, a world away.
Phil Adler:Daniel, can you give us recent examples of a nation using technology in a warlike manner?
Daniel Ortwerth:I'm glad you used the expression warlike because the lines separating peace and war with these kinds of attacks can really get blurred. Here's an example. In early 2010, authorities in the Iranian nuclear program suddenly removed and dismantled roughly 1,000 centrifuges that were being used to enrich uranium,
Daniel Ortwerth:ostensibly for peaceful purposes, purposes, but generally suspected to be a key part of the country's efforts to develop nuclear weapons. They removed the centrifuges because they had been destroyed when their control systems infected by a computer virus, ordered them to operate in a self destructive manner. This damage critically set back the Iranian nuclear program.
Daniel Ortwerth:Although no one has ever taken responsibility for the virus known as Stuxnet, emerging evidence has credibly attributed its development and employment against the Iranian facility to a collaboration between US and Israeli intelligence agencies and Siemens, the manufacturer of the centrifuges. Was this an act of war? At any rate, none of the 3 have ever confirmed or denied association with Stuxnet.
Phil Adler:Daniel, I suppose at the very least, the country might be prone to consider using more conventional weapons in response to a technological attack.
Daniel Ortwerth:Well, the risk is certainly there. This is all so new that we really do not know how to expect national governments to respond in the wide range of scenarios that could unfold. In fact, from our review of the guiding documents that various world militaries have published thus far, we see evidence that the armed forces and the governments themselves are still trying to get a handle on this.
Phil Adler:Daniel, as the world divides into competing geopolitical blocks, our main enemy is very often recognized as China. Now in terms of initiating high-tech attacks, what are China's capabilities?
Daniel Ortwerth:For the last 3 decades, in addition to its military buildup, China has heavily and steadily invested in an entire suite of capabilities that span a wide range such as cyber attack capabilities, lasers capable of blinding satellites, GPS jamming equipment, and artificial intelligence generators to produce false information. Along with its heavy investments in these areas, in 2015, the Chinese military established a new and independent organization, which they call the Strategic Support Force or SSF. The SSF unifies and integrates all of these capabilities into one command structure, and it further coordinates them with the rest of the military, the Chinese Communist Party, and the Chinese government.
Phil Adler:Are China's intentions clear?
Daniel Ortwerth:Intentions are always somewhat of a mystery, but we can get a sense of them by what a country publishes in its documents and what its leaders say in public. The core operational concept for the Chinese military is called multi domain precision warfare, which incorporates advances in data science and artificial intelligence with the rest of their capabilities to rapidly identify key vulnerabilities in an enemy's operating system, then combine joint forces of all types to launch precision strikes, whatever kinds of strikes those might be against those vulnerabilities. This concept is nested within what China refers to as a new way of war that views war as an ongoing confrontation between opposing systems rather than just a confrontation of military forces. Now deeper study of the documents reveals an intention to employ any combination of civilian and military resources against a prospective enemy to weaken it in any way that produces an advantage.
Phil Adler:Daniel, do you think we are already at war with China?
Daniel Ortwerth:Phil, that would be an extremely bold bold assertion to make. And at Confluence, it is not our place to make that statement. However, we pay close attention to the leading voices across the spectrum of thought, and more than one of those voices is making that assertion.
Phil Adler:Well, what can investors expect in a in a wartime footing scenario?
Daniel Ortwerth:2 main societal burdens of war are inflation and higher interest rates. Now many other things also cause inflation and rising rates. This is not to say that if rates and inflation are rising, we must be at war. But it is to say that if we are at war, we should expect rising rates and higher inflation for at least the duration of the conflict. This held true even during the 46 year cold war, a period when, on average, both inflation and rates were higher than they have been in the 30 years since then.
Phil Adler:In this type of environment, do you recommend what are traditionally seen as safe investments? For instance, US Treasurys.
Daniel Ortwerth:Actually, Treasurys might not be the best wartime choice. Let's again use an example from history to see why. During World War 2, the US Treasury forced the Federal Reserve to fix interest rates along the entire yield curve, meaning all of the maturities from 3 months out to 30 years to keep borrowing costs low for the government. To perform this role, the Fed was required to buy up treasury debt leading to a massive expansion of its balance sheet. At Confluence, we expect something similar this time.
Daniel Ortwerth:However, just because long rates do not rise, and this is a caution to investors, that does not necessarily make long maturity treasuries a good investment. By artificially holding down bond yields, such a policy would mean that bondholders would lose money slowly in real terms even if the actual prices of the treasuries do not decline because the rate of return would be less than the rate of inflation.
Phil Adler:Well, how is Confluence Investment Management preparing for this new world?
Daniel Ortwerth:Well, Phil, the simple and short answer is that we have chosen to incorporate the heightened risk of war and its effect on inflation and interest rates into all of our analysis and recommendations across the range of our products, services, and relationships. If the country goes to a wartime footing, then we need to help the investor to get there too.
Phil Adler:Thank you, Daniel. We remind our listeners that this discussion is based upon sources and data believed to be accurate and reliable.
Phil Adler:Opinions and forward looking statements expressed are subject to change without notice, and this information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stoll. I'm Phil Adler.